In volatile markets, investors often face the dilemma of whether to invest or to wait for the prices to fall further. While investing at market bottoms undoubtedly yields higher returns it is almost impossible to time the market. The year to date Sensex chart below will show the challenges in trying to time the market. You can see that Sensex made multiple bottoms from which it rebounded only to correct again later. Such market conditions are often confusing for average retail investors.
Source: Source: Bombay Stock Exchange
We have seen that investors usually prefer to wait till they have some kind of confirmation that the correction is over or feel confident that uptrend has resumed. The problem with the wait and watch approach is that, recoveries from deep corrections is usually quite fast in India and investors miss out on the opportunity of investing at or near market bottoms. Fortunately through mutual fund Systematic Transfer Plans (STP) investors can take advantage of price volatility by reducing their investment costs through Rupee Cost Averaging, thereby earning superior returns in the future.
What are Systematic Transfer Plans?
Mutual Fund STP essentially is a mechanism to transfer funds systematically from one mutual fund scheme to another. You can use STP to invest your lump sums in equity mutual funds in a systematic manner in volatile market conditions, by investing a low risk debt mutual fund scheme like a liquid fund and transferring fixed amounts at regular intervals (weekly, fortnightly, monthly etc.) to the equity mutual fund scheme of your choice over a specified period of time (e.g. 3 months, 6 months, 12 months etc.).
How Systematic Transfer Plans work?
Let us assume you have Rs 10 lakh of lump sum money which you want to invest in an equity mutual fund. However, you are unsure about the price at which to buy the equity fund units due to volatility in the market. Let us now assume that we expect volatility to last for 3 – 6 months more. You can invest your lump sum funds in a liquid fund and transfer equal amounts to equity fund at monthly intervals over your chosen STP tenure, say 6 months. So every month Rs 1.67 lakhs will get transferred from your liquid scheme (through redemption at the prevailing NAVs) to equity scheme – units of the equity schemes will be purchased at prevailing NAVs. If NAV of equity scheme keeps falling, with every STP instalment you will be buying a higher number of equity scheme units. Also, since your liquid fund will increase in value over time, you will redeem lesser and lesser number of units of liquid fund units for your STP to equity fund. The twin benefits of Rupee Cost Averaging and Liquid Fund returns during the STP tenure will boost your returns in the long term.
Advantages of Systematic Transfer Plans
- By investing at regular intervals you will be buying at different price points. In a volatile market, you are likely to buy at lower prices, thereby reducing the average cost of purchase
- Mutual Fund Systematic Transfer Plan (STP) does not require you to time the market. You do not have to follow the daily market movement, support and resistance levels, analyze macro-economic data, company news etc. Once you setup an STP, you will benefit through Rupee Cost Averaging as long as volatility persists
- STP will provide stability and liquidity to your portfolio because your equity exposure will increase gradually
- You will earn returns from your liquid or debt fund investment throughout the STP tenure. This will also boost your returns in the long term
- You can stop your STP at any time and switch your balance liquid / debt fund units to your equity fund if you think uptrend has resumed
Illustration of financial benefit of STP
We will illustrate with an actual market example. Let us assume that we go back in time to December end 2015. From its high (made earlier in that year) the market (Sensex) had fallen 13% by the year end. 12 – 15% correction often provides attractive investment opportunities, but investors were concerned about continuing volatility due to falling crude prices and fears of global recession.
Let us assume you wanted to invest Rs 10 lakh through monthly STP (Rs 1.67 lakhs / month) over the next 6 months from 1st January 2016. You invested your money in S&P BSE Liquid Rate Index (proxy for liquid fund) and transferred equal amounts every month (beginning 1st January 2016) to BSE Sensex Total Return Index (proxy for equity fund) over the next 6 months till June 2016. The table below shows, your debt and equity investment values for each STP transaction.
Source: BSE, S&P Asia Indices
You can see that, as on 1st June 2016 even after transferring Rs 10 lakhs to the Sensex TRI through STP (Rs 1.67 lakhs /month for 6 months), you still have around Rs 41,500 balance in S&P BSE Liquid Rate Index. This is essentially, the income generated by the liquid fund during the STP tenure. Since the Sensex was rising continuously for the last 3 months (from March 2016 onwards) you would have felt confident about the uptrend and switched the liquid rate index investment balance to Sensex. At the end of the STP tenure and switch of balance liquid scheme units to equity, you would have accumulated 29.52 units of Sensex TRI.
Let us compare investment growth different lump sum investment scenarios versus the STP till date (as on 1st August 2019). You can see that through STP you made Rs 1.1 to 1.5 lakhs higher profits. This shows how STP is beneficial in volatile market conditions.
*Sensex TRI value on 1st August 2019 was 53,887.88 (BSE)
In this blog post, we have discussed how STP can help you take advantage of market volatility and generate superior returns for you in the long term. One question that we often get from investors is about the tenure of STP. We have seen that 3 – 6 months STP is effective for large cap and large cap oriented schemes. For midcap and small cap schemes longer tenure STPs can be effective. As discussed in this post, if you feel that uptrend has resumed you always have the flexibility of stopping your mutual fund Systematic Transfer Plan. Investors should consult with their financial advisors, if STP is a suitable investment strategy in these market conditions.
Suggested reading: Why it is a right time to invest in equity mutual funds
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.